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TIPS. Treasury Inflation-Protected Securities, or TIPS, are U.S. government bonds, first issued in 1997, that automatically go up in value when inflation rises. Because the full faith and credit of the United States stands behind them, all Treasury bonds are safe from the risk of default (or nonpayment of interest). But TIPS also guarantee that the value of your investment won’t be eroded by inflation. In one easy package, you insure yourself against financial loss and the loss of purchasing power.12

There is one catch, however. When the value of your TIPS bond rises as inflation heats up, the Internal Revenue Service regards that increase in value as taxable income—even though it is purely a paper gain (unless you sold the bond at its newly higher price). Why does this make sense to the IRS? The intelligent investor will remember the wise words of financial analyst Mark Schweber: “The one question never to ask a bureaucrat is ‘Why?’” Because of this exasperating tax complication, TIPS are best suited for a tax-deferred retirement account like an IRA, Keogh, or 401(k), where they will not jack up your taxable income.

You can buy TIPS directly from the U.S. government at www. publicdebt.treas.gov/of/ofinflin.htm, or in a low-cost mutual fund like Vanguard Inflation-Protected Securities or Fidelity Inflation-Protected Bond Fund.13 Either directly or through a fund, TIPS are the ideal substitute for the proportion of your retirement funds you would otherwise keep in cash. Do not trade them: TIPS can be volatile in the short run, so they work best as a permanent, lifelong holding. For most investors, allocating at least 10% of your retirement assets to TIPS is an intelligent way to keep a portion of your money absolutely safe—and entirely beyond the reach of the long, invisible claws of inflation.

Chapter 3

A Century of Stock-Market History: The Level of Stock Prices in Early 1972

The investor’s portfolio of common stocks will represent a small cross-section of that immense and formidable institution known as the stock market. Prudence suggests that he have an adequate idea of stock-market history, in terms particularly of the major fluctuations in its price level and of the varying relationships between stock prices as a whole and their earnings and dividends. With this background he may be in a position to form some worthwhile judgment of the attractiveness or dangers of the level of the market as it presents itself at different times. By a coincidence, useful statistical data on prices, earnings, and dividends go back just 100 years, to 1871. (The material is not nearly as full or dependable in the first half-period as in the second, but it will serve.) In this chapter we shall present the figures, in highly condensed form, with two objects in view. The first is to show the general manner in which stocks have made their underlying advance through the many cycles of the past century. The second is to view the picture in terms of successive ten-year averages, not only of stock prices but of earnings and dividends as well, to bring out the varying relationship between the three important factors. With this wealth of material as a background we shall pass to a consideration of the level of stock prices at the beginning of 1972.

The long-term history of the stock market is summarized in two tables and a chart. Table 3-1 sets forth the low and high points of nineteen bear- and bull-market cycles in the past 100 years. We have used two indexes here. The first represents a combination of an early study by the Cowles Commission going back to 1870, which has been spliced on to and continued to date in the well-known Standard & Poor’s composite index of 500 stocks. The second is the even more celebrated Dow Jones Industrial Average (the DJIA, or “the Dow”), which dates back to 1897; it contains 30 companies, of which one is American Telephone & Telegraph and the other 29 are large industrial enterprises.1